Geithner Details Plan for Major Federal Financial Regulation Reforms

March 26, 2009 at 6:00 PM EDT

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Telling lawmakers that the U.S. financial system has grown "too unstable and fragile," Treasury Secretary Timothy Geithner rolled out the Obama administration's plans Thursday for a massive overhaul of the government's financial oversight role.

JIM LEHRER: The Obama administration rolled out a broad expansion today of the financial regulatory system. Treasury Secretary Timothy Geithner outlined a system to control hedge funds, large insurance companies, and others outside the banking industry.

NewsHour correspondent Kwame Holman has our lead story report.

REP. BARNEY FRANK (D), Massachusetts: The Committee on Financial Services will now convene.

KWAME HOLMAN: Secretary Geithner was on Capitol Hill for the second time this week. He said the country needs new regulations to fix a system that’s “too unstable and fragile.”

TIMOTHY GEITHNER, Treasury Secretary: Not modest repairs at the margin, but new rules of the game. And the new rules must be simpler and more effectively enforced. They must produce a more stable system…

KWAME HOLMAN: Geithner laid out the stakes early in a hearing before the House Financial Services Committee.

TIMOTHY GEITHNER: What we need is better, smarter, tougher regulation, because we’ve seen that the costs of these weaknesses and gaps are catastrophic to the system as a whole.

And we have an enormously complicated system in the United States, with regulation at the federal and state level, multiple bank supervisors, multiple authorities, and it just didn’t work. It did not deliver what it has to deliver.

KWAME HOLMAN: Specifically, the administration wants to rein in those firms, such as AIG, that ended up putting entire sectors of the economy at risk.

The proposal would: create a regulatory regime to oversee systemic risk in the economy; for the first time, complex financial instruments, such as credit default swaps that brought down AIG, would be regulated, and not just at financial services firms; the government also would be empowered to seize large insurance companies, hedge funds, and the like, if they endanger the economy. Currently, only banks are subject to federal takeover.

David Scott, Democrat of Georgia, asked who would exercise that new and broadened authority.

REP. DAVID SCOTT (D), Georgia: Where in the federal government should that power rest? Should it be with you in Treasury? Should it be in the Fed or perhaps in FDIC?

TIMOTHY GEITHNER: Well, what we’re proposing to do is build on the model established for the FDIC for banks and thrifts. That model, we’ve had a lot of experience with it. There’s a whole range of important checks and balances in that system to limit discretion, so the existence of this does not increase moral hazard.

KWAME HOLMAN: Some Republicans complained regulators could gain too much power. California’s John Campbell wondered if the administration foresaw some new disaster ahead that’s driving the proposals.

REP. JOHN CAMPBELL (R), California: Are you expecting some additional non-bank failures? Are you concerned about that?

TIMOTHY GEITHNER: You know, we’re still in the midst of a very challenging period. And so I think it would be in the interests of the country for Congress to do everything they can to make sure we got broader tools so we can manage this effectively.

KWAME HOLMAN: The secretary acknowledged there’s no guarantee the plan will forestall future trouble, but it could make problems less harmful and less expensive.

TIMOTHY GEITHNER: Nothing we do here today over the next six months will offer the prospect of preventing all future financial crises. We can make sure that, when they happen in the future, we can act more quickly, more effectively to contain the damage, to put a fire break around the most weaker parts of the system, to not allow the fire to jump.

KWAME HOLMAN: Earlier, the committee voted to let Secretary Geithner and others decide if executive bonuses at AIG and similar firms are “unreasonable or excessive.” The drive to impose punitive taxes on the bonuses has slowed, but House Speaker Nancy Pelosi said today the message has been sent.

REP. NANCY PELOSI (D-CA), Speaker of the House: We want to make sure that what we are doing makes the distinctions between the abuses and the insult to the taxpayer of an AIG employee — executive who drove his company into the ground, costing over $100 billion of dollars of taxpayer dollars, and then taking taxpayer dollars as his reward for failure. That is something quite different than the normal compensation practices that have bonuses and performance as part of it.

KWAME HOLMAN: The committee’s proposal to restrict bonuses could come to the full House within days. And the administration also has sent Congress a 61-page bill containing the regulatory changes Secretary Geithner outlined today.

Filling in regulatory gaps

Paul Kanjorski

Democratic Congressman

I think we should have overseers. I think we should have analyzers and reviews. And I don't think we should construct another regulatory body.

JIM LEHRER: And Judy Woodruff gets some congressional reaction to this new proposal.

JUDY WOODRUFF: And for that, I'm joined by two members of the committee which heard from Secretary Geithner today.

Rep. Paul Kanjorski is a Democrat from Pennsylvania and chair of the Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises. And Rep. Ed Royce is a Republican from California.

Gentlemen, thank you both for being with us.

Congressman Kanjorski, I'm going start with you. This notion that there needs to be a systemic regulator, an entity somewhere in the government to deal with these firms that are so-called too big to fail, is that a good idea? Is that the right approach?

REP. PAUL KANJORSKI (D), Pennsylvania: Well, I think we're misusing the concept of a regulator in saying a systemic regulator, because that's an after-the-fact conclusion. It seems to me very difficult to assume that someone could be looking over an organization or economic activity and anticipate that it will be a systemic risk to the system.

I think we should have overseers. I think we should have analyzers and reviews. And I don't think we should construct another regulatory body.

I think what we should really do is see how our existing regulation can be better utilized, smarter, as the secretary said, and then fill in the gaps that aren't regulated and make sure they function well, and then construct something, like Sen. Collins' suggested bill, to have a review made to see whether or not there are obvious problems that could cause systemic risk there.

JUDY WOODRUFF: Well, I guess, Congressman Royce, what we're hearing from the administration is they're looking at the Fed, the Federal Reserve, being the place where this systemic big regulatory body would exist. I mean, do you agree with Congressman Kanjorski's interpretation that we don't need something new to do this?

REP. ED ROYCE (R), California: Well, yes, exactly. We had certain gaps in the regulatory structure that should have been covered. But what we're doing here or what's being suggested by the administration is sort of permanent TARP authority.

And I voted against the original TARP; I voted against the bailout. And my concern with this is that any large firm then basically has access to that line of credit, could be bailed out by the federal government, and so the message that you send to the marketplace is that this entity is too big to fail and it can borrow at a much lower rate, it can over-leverage, the same way the government-sponsored enterprises, Fannie and Freddie, did.

And the consequences to that are a decline in market discipline, and you've got what economists call moral hazard. So there are downsides to this approach of advancing this concept of all of this TARP funding in the future and bailing out these institutions. And that's part of this.

Targeting regulatory measures

Ed Royce

Republican congressman

Just the fact that they're regulated alone doesn't necessarily solve the problem. You have to have smart regulations, and you have to close those regulatory gaps.

JUDY WOODRUFF: So just quickly, Congressman Royce, what are you saying should be done about these big institutions like Lehman Brothers, like AIG?

REP. ED ROYCE: I think, if we close the regulatory gaps, what I suggested -- I had legislation that would have affected AIG, that would have allowed the federal government to regulate the insurance industry at the federal level, including AIG, and thus they couldn't have been allowed to leverage -- to over-leverage 170 to 1.

They should have been -- you know, banks leveraged 10 to 1. But Fannie Mae and Freddie Mac leveraged 100 to 1, banks, as I say, 10 to 1. We, in fact, had Congress intervening and allowing arbitrage with the government-sponsored enterprises.

So just the fact that they're regulated alone doesn't necessarily solve the problem. You have to have smart regulations, and you have to close those regulatory gaps, as I've indicated.

JUDY WOODRUFF: Congressman Kanjorski, let me turn to one of the other essential proposals here, and that is that there would be regulations for the first time on these so-called financial derivatives, these exotic instruments like the credit default swaps. Comfortable with that? Is that something that everyone agrees should be done?

REP. PAUL KANJORSKI: Oh, yes. I think that that's clear to everyone that we can't have this unregulated silent entity out there that's really providing 50 percent of the credit for this system that none of us really know about and the regulators don't know.

And they're more influential to a large extent than even the banking system in handling transactions of credit. So we've got to get our handle around it. And I think that what we can do is reduce the likelihood of risk in the future if we do that and shed some light on it.

Now, I don't think that Ed and I are that far apart, really. If we put our minds together...

JUDY WOODRUFF: You mean on this point or on the earlier...

REP. PAUL KANJORSKI: On this point and on regulation, on the whole process of what should be done. And that is basically to see if we can strike a bargain that this should never happen again, but it will happen again. It's always going to have something to do. So let's not fool the American people and say, "This could never happen again." It generally happens about historically every 25 years.

We've had great regulation for the last 75 years. Our problem is we didn't identify the problem areas over the last 10, 20 years that have caused now something to go critical.

Now, what we have to do is put in place, close the gaps. Clearly, I agree with Ed on that. Now, the resolution organization that the secretary is proposing...

JUDY WOODRUFF: And just to be clear, that refers to systemic regulators?

REP. PAUL KANJORSKI: No, no...

JUDY WOODRUFF: This is a different...

REP. PAUL KANJORSKI: The regulation authority that the secretary proposed today is an element like FDIC for non-regulated financial institutions, insurance companies, other things that can get into trouble, giving the tools and the authority for the government to move in before they go critical, before it's a choice of either having them go into receivership or into conservatorship.

Instead, we'll be able to deal with them and try and bail them in a way to cost the taxpayer less money themselves.

JUDY WOODRUFF: This is when they get to a critical condition?

REP. PAUL KANJORSKI: Right. Right.

JUDY WOODRUFF: And you are saying you are comfortable with that?

REP. PAUL KANJORSKI: I'm very comfortable with it.

JUDY WOODRUFF: Ed?

REP. PAUL KANJORSKI: I think it closes those loopholes that Ed was talking about and makes it a more manageable system.

Problem of moral hazard

Ed Royce

Republican congressman

Now, we're not talking about the housing market anymore or FDIC-insured institutions. We're talking about ballooning this out with an unlimited line of credit and a great deal of borrowing.

JUDY WOODRUFF: Well, let me quickly ask Congressman Royce on that. Essentially, it's giving the administration the power to take over these big institutions when they are at a critical stage and about to go under.

REP. ED ROYCE: And part of it also is it gives them the ability to offer a line of credit. And with all of this, just as with the government-sponsored enterprises Fannie and Freddie, you have a situation where, when the market knows that institutions like this will be bailed out, they can borrow at a much lower interest rate, they will crowd out their competitors in the market, as Fannie and Freddie came to dominate the mortgage-backed securities market, the market of purchasing and securitizing.

This is one of the side consequences of this that economists worry about. And all of us that watched what went wrong in housing with Fannie and Freddie and how that has worked out worry now, to a certain extent, about how this is being fashioned, because if it really becomes obvious that if you become big enough that you're going to be bailed out and you've got that line of credit right to the Treasury, you're going to borrow at a much lower rate, you're going to eventually leverage more, take more risks, and there's more chance for economic problems as a consequence of the way this is being structured.

And I think that's admitted to a certain extent by Treasury. They're trying to figure out a way to counterbalance those moral hazard risks. I don't think they have yet. I don't think they've figured out how to prevent exactly what happened with Fannie and Freddie from happening here with other would-be government-sponsored enterprises that are going to come out of this, with the government now getting involved in every aspect of the market.

Now, we're not talking about the housing market anymore or FDIC-insured institutions. We're talking about ballooning this out with an unlimited line of credit and a great deal of borrowing.

'Anticipating future needs'

Paul Kanjorski

Democratic congressman

I think that's very healthy. It's anticipating the future needs. I hope we never use them.

JUDY WOODRUFF: And let me ask you -- I want to ask you both, because we've only -- we've got less than two minutes. This would also -- what they're also talking about, Congressman Kanjorski, is extending the regulatory power to hedge funds, private equity firms. Is this something that you think the two Republicans and Democrats can come together?

REP. PAUL KANJORSKI: I think they can. We have to position it right. Let me just throw what we're trying to do or what I anticipate the secretary is trying to do.

Just as in wartime we pre-positioned materiel in order to fight a war a considerable distance away so that when the war starts we have the materiel there or we pre-position for disasters like hurricanes, we put food and equipment in areas, the secretary is trying to pre-position tools that can be used and operated when there's an economic disaster that occurs.

I think that's very healthy. It's anticipating the future needs. I hope we never use them. I agree with Ed that we have to be very cautious as to what powers we give and under what conditions and certainly not to make them more competitive because of the ability to get a better price or a better interest rate than their competitors. That's up to us.

And, incidentally, the secretary today indicated for insurance companies that he's in favor of going to federal regulation of insurance companies, and that's a big victory, because Ed's a part of the co-sponsor of that bill.

JUDY WOODRUFF: All right, gentlemen, we are going to have to leave it there. We appreciate your talking with us. Congressman Ed Royce, Congressman Paul Kanjorski, thank you both.

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